Kraft prepares to climb mountain of debt to avert takeover

Boston
— In a gigantic game of financial one-upmanship, Kraft Inc. put together a $14 billion plan to thwart last week's unexpected $11.5 billion buyout bid by the Philip Morris Companies. Kraft officials announced Sunday a program to recapitalize its stock. The plan would pay stockholders $110 a share with a combination of cash and high-yield bonds, known as junk bonds.

But while the plan would keep Kraft independent and stockholders happy - it also means a mountain of debt on Kraft's balance sheet. Debt would leap about tenfold, from $1.15 billion to more than $12.4 billion. The company will finance the move with $6.8 billion in bank loans and $3 billion in high-yield (junk) bonds.

Philip Morris, the giant cigarette/consumer products manufacturer, had offered $90 a share last week. It must now decide to make a higher bid, or look elsewhere for a takeover candidate. But no matter what happens, Kraft executives are likely to be shaking their heads in collective disbelief.

``The typical defense of a food company is good management, and Kraft is one of the very best-run companies in the industry,'' says John Connor, professor of agricultural economics at Purdue University. ``That was supposed to be the primary defense against takeover.''

Kraft officials say that the company will sell off some non-core businesses, but that it will take extra effort by employees to pay back the enormous debt burden the company will assume. The irony is that while many takeovers are based on the assumption that efficiencies can be gained by putting a new management in place, Kraft has been running a tight ship, industry analysts say.

``Today's situation is not of our making,'' John Richman, Kraft's chairman said in a letter to stockholders. ``Rather, it is the product of current era investment policies and financial attitudes that favor short-term financial gratifications over steady, long-term growth and the need to provide a sound economy for future generations.''

Kraft management is widely admired and has a stable core of managers, whose productivity improvements have been impressive, Dr. Connor says. The company's elaborate marketing system and sales network have helped it gain market share in an increasingly competitive industry.

``The justification of many mergers in the past has been the replacement of poor management by superior management by the parent company,'' Connor says. ``That doesn't appear to be the case here.''

He and other analysts believe it is the huge pile of cash Philip Morris had built up from its highly profitable cigarette operations, more than anything else, that prompted it to bid for Kraft.

``They could not reinvest all that cash,'' says Robert Miles, a professor of management at Emory Business School in Atlanta, who has written a book on the tobacco industry. ``They had to redeploy their capital, because there just is not enough growth in the tobacco business.''

Kraft was vulnerable, in part, because it had been undervalued by the stock market. Analysts say that while food stocks have generally been outperforming the rest of the market, there is still a broad perception that they are conservative - not a choice for high growth. The result is that such stocks, even though doing well, remained relatively undervalued.

``Perception lags reality'' when it comes to food stocks, writes Stephen Grant, an industry analyst with Value Line Investment Survey in New York. ``We think the merits of the industry are still not fully perceived, and good opportunities remain.''

In a recent interview, Mr. Grant said the Philip Morris bid for Kraft is ``going to shake things up a little bit,'' causing food stocks ``rise in sympathy'' with Kraft's upward valuation.

Capping off last week's whirlwind of huge buyout efforts was RJR Nabisco's surprise bid by its managers to raise $17 billion to take the company private. The leveraged-buyout bid was the biggest ever - at the time. But on Monday, the investment firm Kohlberg, Kravis, Roberts &amp; Co. announced a $20.28 billion tender offer for RJR Nabisco.

``Management has decided that the company should be sold. Our offer is a better one,'' Henry Kravis, a partner in the New York-based leveraged-buyout specialist firm, said in a statement.

The Kohlberg, Kravis offer was for $90 a share in cash and securities, compared with the management buyout proposal of $75 a share in cash.

Securities analysts said last week the plan by RJR Nabisco management was a preemptive strike to protect the company that manufactures such brand names as Camel cigarettes and Oreo cookies.